The Dangers of Interns, and of Not Paying Your Friends to Help Your Business

Linda has just formed an LLC.  She has a great new idea for a business.  She has no money as she has no clients yet, but her friends love her and want to volunteer their services. She has vaguely promised them some sort of eventual profit or ownership percentage when the company becomes more successful.  Or even better, she has found a college student who wouldn’t mind “interning” (otherwise known as working without pay) who will help her run her errands in return for a line on a resume or a referral letter.

Student

(Photo credit: CollegeDegrees360)

Linda has a problem.  Most unpaid internships are illegal and violate the minimum wage and overtime laws.  The United States Department of Labor has put out a fact sheet that delineates the test for unpaid interns.  Here are two particularly sticky tests for Linda:

  1. The intern does not displace regular employees, but works under close supervision of existing staff;
  2. The employer that provides the training derives no immediate advantage from the activities of the intern; and on occasion its operations may actually be impeded.

In other words, Linda should be paying her intern at least minimum wage.  She’s getting all the benefit.  By having an intern, she is able to not hire an employee, and she’s certainly getting an advantage.

The same thing is true for her friends that she has offered some eventual piece of the profits.  First, the terms of the deal should be in writing so that everyone understands exactly what they are giving and what they can expect to get in the end when the business is successful.  Second, without an agreement, this is just another form of unpaid labor that is likely to lead to violations.

How will this end up being a huge problem for Linda?  One of the unpaid workers files a claim against Linda, for unemployment benefits; for worker’s compensation if they get hurt on the job; for another employee harassing them.  Linda is facing huge fines for not properly paying her employees and for not paying the proper taxes.

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Would You Like to be Partners with your Partner’s Spouse?

I have a business acquaintance named Fred, and Fred has a partner named Janet. They make a great team. Fred is a classic entrepreneur type, ready to go off in six directions at once as soon as an idea hits him. Janet keeps his feet on the ground. She’s great at systems, finances, and Fred loves having her as a partner. Together they have built a successful business.

Husband Wife Friends

(Photo credit: GoodNCrazy)

As far as Fred is concerned, Janet is perfect, except for one thing. She has a husband, Albert, who is a jerk. Over the years, he has held one job after another and doesn’t succeed at any. Fred suspects there may be a drinking problem. Occasionally, not often, Fred has overhead Janet crying in the bathroom. He has never talked to her about it, not wanting to intrude on a family matter.

Then one day, the unthinkable happened. Janet was returning from lunch on a rainy day. As she stepped into the crosswalk, a speeding car slammed on the brakes, skidded, and…Janet was killed in the accident.

Fred, meet your new partner, Albert. It was a real mess. Fred didn’t have the cash to buy-out Albert and pay Albert 50 percent of what the firm was worth. In any case, without Janet, it wasn’t clear at all what that value might be. At the same time, Fred felt he could not work with Albert. Fred visited a few banks, but nobody wanted to lend him the money to get rid of Albert.

All this could have been avoided if Fred and Janet had a “buy-sell agreement” as part of their partnership.  They could have purchased insurance on each other’s lives so they wouldn’t have to be partners with the other one’s spouse, or even worse, their partner’s children.  An agreement would have valued their business properly, so there was no long court battle as to what the business was worth to each of them.

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Your Family Small Business Succession Plan

When your business succession planning involves family, a whole new set of variables need to be thought about.

In some ways, it is easier when you have family to leave your business to, in other ways it can be way more difficult as you add family dynamics to the mix

First of all, some statistics: according to the Small Business Administration and researchers at Baylor University’s Institute for Family Business, only 30% of family businesses survive from one generation to the next, and even fewer to a third generation.  The mostly commonly given reason for this huge drop is the lack of a plan for an orderly succession.

If you own a family business, and would like to see your business survive  into the next generation, there are a few questions you should address:

  • Do your children or grandchildren want to take over your business?  It is never a good idea to insist your children take over the business.  You know how much hard work it is to make the business you love succeed, imagine if it was not a passion.
  • Is the interested family member qualified?  Has that family member worked in the business?  Learned skills at school or on the job?
  • If you have more than one child, there are other possibilities to consider.  More than one of your children may want to go into the business, but it is possible that some will not.   Many of us want to treat our children fairly when we leave our assets in our wills.  Can you treat your children fairly if leaving the business to one child?
  • If no family members want or are capable of running your business, do you want to hire management to run the business while retaining ownership, or does it make more sense to sell the business?

This is not a decision the business owner should make on his or her own.  The best thing to do is to sit down with your family and discuss it.

One of the most important aspects of family succession planning is estate planning.  If you are ready to start planning for the next generation, contact your Long Island small business lawyer soon.

Overpromising? “Limited” Liability and Small Business

If you are just starting a small business or have a sole proprietorship, you have probably thought about and received advice about either incorporating or forming a limited liability company (LLC).

What protections do these business entities actually offer to the small business owner?

The Promise

You have probably heard that by incorporating or forming an LLC,  you, as the owner, will be protected from personal liability, whether  through contract (from creditors) or tort (from intentional or negligent wrongful act, injury or damage other than breach of contract).

This is true to a great extent.  However, as a small business owner you are probably not totally shielded from personal liability even if you do incorporate or form an LLC.

The Reality

Leases

Commercial landlords will often demand a personal guarantee from the principals or owners of the small business despite business entity status.  A lease is a contract between a landlord and a tenant.  If you have not been in business for very long or your business assets are limited, you can expect to be asked to personally guarantee a lease.  Your spouse may also be asked for a personal guarantee.  Depending on how long you have been in business or how in demand the property is, this may be a negotiable point. You might want to contact a business attorney to review and negotiate your commercial lease.

Loans

Bank loans. Whether you need a loan to finance inventory or to expand, a lender may require you  put up your personal property as collateral.  Even  if your business were to dissolve, you would remain personally liable for paying back the loan.  However, depending on the business’ creditworthiness, this too is open to negotiation.

Small Business Administration loans.  The SBA requires that all loans they guarantee must be collateralized with both the business assets and a personal guarantee.  Often you may need to take out a second (or third) mortgage on your home.  Nevertheless, SBA loans often have excellent terms.

Credit Cards

Most business credit card issuers will not approve a business application unless the owner personally agrees to be liable for any debt incurred.  Take note that any default on your business card will impact your personal credit.  After several years of being established, you may want to ask the issuer to allow you to separate your business and personal liability.

Torts

Your own acts.  Corporate/LLC formation provides protection for corporate acts;  it may not provide protection for your own acts.  Even if you are acting for the corporation, if you are negligent you are potentially personally liable. You can’t commit intentional wrongdoing even in the guise of your corporate self.  You can’t embezzle, defraud or assault someone.

Your employees’ acts.  Although in theory, the corporation or LLC should shield your personal assets from your employees’ bad acts, in reality, if the act is egregious enough you are likely to be brought into the lawsuit.  Negligent hiring, failure to ensure the person you sent on an errand has a clean driving record, or negligently maintaining your property are just some of the ways you personally can be brought into litigation, even though you’re incorporated.  This doesn’t necessarily mean you will lose the lawsuit, however, even good defenses cost money.

Taxes

You can be held personally liable if  the corporation neglects to pay over to the IRS  the employees’ share of withholding and social security taxes.  Many states also will hold corporations personally liable for failure to turn over retail sales taxes due from the corporation.

The Solution

Despite some pitfalls and incomplete protection, it is still worthwhile to either incorporate or form an LLC.  Business formation will protect your personal assets to a great extent.  The longer your business exists,  the more creditworthiness your business can show, the better your bargaining power will be with landlords, credit card companies and lenders.

Insurance

It is a good idea to ensure you have sufficient personal insurance coverage on your assets to cover any business liability.  Consider buying an umbrella policy for your cars and home.  Insuring your business is also a necessity.  Should you get sued, the insurance company will defend you, pay for your attorney and pay up to policy limits.

Insurance Needs of the Sole Proprietor

One major concern for many small businesses and sole proprietors is what type of insurance is required in New York.  Below is a brief description of the most important types of policies you should consider:

Health Insurance

While a number of private insurance companies offer health insurance for sole proprietors, New York has a special program, Healthy New York, that aims to promote and provide affordable insurance coverage to both sole proprietors and small businesses  that do not currently offer health insurance to their employees.  To apply for the program, click on the following link:  Healthy New York Application for Individuals and Sole Proprietors.

Additionally, the New York State Department of Insurance compares health insurance programs from several companies in this chart.

Disability Insurance

Basic disability insurance is used to replace the owner’s income in the event of a disability.  This type of insurance is often ignored despite the risk of becoming disabled being far higher than the risk of dying prematurely.

Another type of disability insurance known as Business Overhead Expense Insurance  is designed to allow a small business to stay viable while its owner recovers from a short-term disability.

Other potential disability insurance options to consider are policies that help fund the buyout of the disabled owner’s share or insuring an employee if the business is dependent on the skills of that key person.

Life Insurance

A sole proprietor life insurance policy specifically deals with what will happen to your business in the event something happens to you.  Life insurance helps to ensure that your family will not be responsible for the debts of the business and will help to avoid a forced liquidation to pay those debts.

Life insurance is also the most efficient way to fund a buy/sell agreement in a closely held corporation, partnership or LLC.  A buy/sell agreement is a contract among business owners that allows the other owners to buy the deceased person’s interest in the business.

Unemployment Insurance

If you have one or more employees, you are required to carry unemployment insurance in New York.  A useful publication is the Employer’s Guide to Unemployment Insurance, Wage Reporting and Withholding Tax.

A sole proprietor without employees is not required to pay unemployment insurance taxes on his/her salary, but a stockholder/employee of a corporation must.

Workers’ Compensation Insurance

If you have employees in New York, you are required to obtain workers’ compensation insurance from either an insurance carrier authorized by the New York Workers’ Compensation Board or you may self-insure if authorized by the Board.  The cost of this insurance must be borne entirely by the employer. This coverage is not required for a sole proprietor with no employees.  It is important to know that a sole proprietor with employees is not automatically covered but must elect to be included by filing a Form C105.32.  This form must also be elected by partners and members of  an LLC or LLP.

Property and Casualty Insurance

All small businesses, including home-based businesses, should carry property and casualty insurance in case of loss for inventory, equipment and potential injuries to customers, vendors and employees.

The above list is not intended to be complete.  Your small business may have specific requirements that depend on the type of business (for example, malpractice insurance is certainly high on my list of necessary insurance coverage).  If you have any other suggestions, please feel free to contact me or comment below.